Competition In An Internet Mall: A Strategic Analysis of A New Marketing Venue

Retailers strive to differentiate themselves from competitors to avoid commoditization and consequent price competition, using tools such as store location, store layout, and product assortment. However, such tools become ineffective on the Internet, where competitors are a few clicks away, where web page design can be easily imitated, and where online shoppers can browse a variety of product categories at ease, making price comparisons using search engines. Thus, an integrated online shopping environment such as that provided by an Internet mall would seem to be particularly unattractive to retailers. Yet, Internet malls have emerged as an important electronic shopping environment that, according to a recent Forrester Research report, may evolve into a dominant force in Internet marketing. The purpose of this essay is to provide an explanation for this puzzle. We show that an Internet mall reduces price competition among online stores by leveraging two notable features: the search engine and the featured store. The search engine facilitates price comparisons but requires consumers to spend time going through pages of search results. In contrast, consumers are directed to the featured store with a single click. Consumers trade off price reductions with reductions in search time, leading to higher prices in the featured stores and a consequent softening of price competition. We investigate a homogeneous product market with heterogeneous consumers. We assume that consumers differ in their sensitivity to price and to the cost of time. Search costs are the product of a category specific search time and unit time cost. To choose between search engine driven comparison shopping and featured store shopping, consumers form price expectations that help them compare the reduction in price obtained by searching with the cost of the search itself. We find that competition is reduced. In addition, we find that as search costs increase, the price differential between the featured stores and non-featured stores becomes larger, as is also the case when more shoppers purchase through the mall. We also find that a mall should feature stores for free when more shoppers purchase through it and when consumer search costs are substantial. Conversely, it should charge fees to featured stores when fewer people purchase there and search costs are low. Finally, while a large mall should charge percentage fees to participating stores, a small Internet mall may optimally offer free participation to online stores. Preliminary empirical analysis supports our conclusions.